OSLO, Feb 9 (Reuters) - Norway's tax rules for the oil industry do not constitute state aid, its finance ministry told a European competition watchdog on Friday.

The competition watchdog of the European Free Trade Association (EFTA) is investigating the tax regime following a complaint by Norwegian environmental group Bellona.

Environmental groups, including Greenpeace, have also mounted a legal battle in Norway to try to stop the government from expanding exploration areas in the Arctic.

"The Ministry maintains that the Norwegian rules on reimbursement of exploration costs and interest on carry forward of losses ... do not constitute state aid under Article 61 of the EEA Agreement, and are therefore in compliance with the EEA (European Economic Area) law," the ministry said in a letter.

Norway allows companies to deduct 78 percent of their exploration costs from taxable income. Since 2005, companies without taxable income have been reimbursed for the value of this benefit directly in cash.

Bellona's complaint focuses on those provisions for the up-front cash flow reimbursement of exploration costs, which the organisation argues are in breach of state aid rules of the EEA.

This has so far amounted to over 100 billion Norwegian crowns ($12.54 billion). In 2014 alone, the government paid 14.2 billion Norwegian crowns in reimbursements to the petroleum sector.

"This means that if income is derived from petroleum activity taxed at a rate of 78 percent, the state, through the tax system, should cover a corresponding share of the cost incurred to earn this income," the ministry said.

The government argues that the scheme can generate trillions of crowns in future tax payments for the state.

Bellona says that the state, as tax collector, should not trade such benefits for future gain.

Norway, western Europe's largest oil and gas producer, is seeking to attract more oil firms to explore in the Arctic Barents Sea.

Environmentalists oppose the move and says reserves found in the Arctic might be never extracted because of measures to counter climate change, while the state will be left to reimburse exploration costs.

The EEA comprises the European Union and three EFTA states, Norway, Iceland, Liechtenstein, and has been discussed as one of the options for Britain after it quits the European Union. ($1 = 7.9730 Norwegian crowns) (Reporting by Nerijus Adomaitis; Editing by Andrew Roche)